Will Goldman’s Scandal Prompt Cultural Changes on Wall Street?
Updated July 15, 2010 – 3 p.m.
On the same day Congress passed sweeping financial-reform legislation, Goldman Sachs & Co. agreed to pay $550 million to settle fraud charges. The charges accused Goldman of fraud in mortgage investments. That includes $300 million in fines assessed by the Security and Exchange Commission – the largest in SEC history.
The remaining balance of $250 million goes to the victims.
You might recall that Goldman’s mortgage-related investments were designed with participation by a Goldman client, Paulson & Co. Paulson bet those investments would not succeed, and they didn’t.
Goldman is now forced to assess its procedures in such financial mortgage deals. The catalyst was the investments that cost investors nearly $1 billon, but the deal netted Paulson huge sums of money. It was also part of the mega mortgage meltdown that helped to exacerbate the nation’s economic downturn.
“This settlement is a stark lesson to Wall Street firms that no product is too complex, and no investor too sophisticated, to avoid a heavy price if a firm violates the fundamental principles of honest treatment and fair dealing,” said Robert Khuzami, the SEC’s enforcement director.
A federal judge in New York will rule on the settlement.
The case against Goldman gathered steam when a published report added impetus to fraud allegations against Goldman. The Sacramento Bee alleged Goldman secretly worked to dump “billions of dollars in risky mortgage securities and buy exotic insurance” in anticipation of the housing bubble. But the report said Goldman hid its actions from the Securities and Exchange Commission for nine months in 2007 (“Goldman didn’t disclose its subprime mortgage hedges”).
At issue: Opponents eventually proved that Goldman’s gambling was so relevant – investors would not have bought Goldman’s offerings.
The furor over that controversial 2007 mortgage derivatives deal underscores the fear of many Americans that the market is rigged against them because Wall Street is a haven for questionable behavior.
The Security and Exchange Commission’s triumph over Goldman’s handling of the collateralized debt obligation (CDO) in subprime mortgages shows the Wall Street sheriff is back and is flexing some muscles.
Furthermore, Goldman’s failure to disclose that a hedge fund manager, John Paulson, helped select the underlying securities and then bet against them to make more than $1 billion is bad enough.
It’s looked even worse after Bloomberg reported Goldman knew it was under investigation for nine months but failed to disclose the investigation in their financial reports to investors.
Such omissions triggered the shareholder legal action.
The resulting headlines are reminiscent of the financial-greed scandals involving the 1980’s shadowy behavior of convicts Mike Milken and Ivan Boesky, as well as the principals at Enron and Worldcom.
Several questions have arisen:
- Is the SEC action really the tip of the iceberg of upcoming legal challenges?
- Will it lead to a stock market correction?
- Will it end the entitlement attitudes seemingly held by many investment bankers?
- Will it improve the culture in the financial sector?
This case was an ideal situation for New York’s litigious community.
It led to a decline of Goldman shares – 13 percent – as well as the shares of other financial companies trading in CDOs, including Deutsche Bank AG, Morgan Stanley, Bank of America (the parent of Merrill Lynch) and Citigroup.
In addition, a Chicago online publication, ProPublica, reported on questionable bets by Magnetar and allegations of conflicts of interest by the latter three financial firms. Magnetar denied culpability and none of the three banks denied or commented on the allegations.
Indeed, the same day that the SEC acted against Goldman, April 16, a Dutch bank leveled similar charges against Merrill Lynch. Cooperatieve Centrale Raiffeisen-Boerenleenbank BA, or Rabobank, cited Merrill Lynch in a $1.5 billion CDO.
Sadly, regarding Wall Street’s entitlement attitudes and culture, the consequences might not be severe enough to prompt an attitude adjustment.
Not to be cynical, here’s the bottom-line question: Are there enough moral compasses on Wall Street to put a stop to the chicanery? Probably not.
From the Coach’s Corner, for more on Sen. Cantwell’s efforts, see “Sen. Cantwell Is Right to Question Risky Derivative Dangers, Geithner.”
Management — Why It’s a Mistake to Overlook Succession Planning
Updated May 22, 2011
First, it was Bank of America. Then, a second major financial institution exhibited questionable management. Both are examples of dubious succession planning, and investor and customer relations.
You might recall HSBC CEO Michael Geoghegan threatened to quit if he wasn’t named chairman. His widely publicized threat didn’t work. Instead, HSBC named Stuart Gulliver CEO, replacing Mr. Geoghegan, who retired at the end of 2010. Mr. Gulliver had been in charge of HSBC’s investment banking operations.
Bank of America’s situation was different. But it also is among many businesses teaching us valuable lessons about management. From the stakeholders’ point-of-view, B of A took an exasperating long time to name a new CEO. The delay suggested that the B of A board and outgoing CEO Ken Lewis bungled by not succession planning.
Critics point out the significance of the job and why it’s important for a new CEO to get a running start.
But Brian Moynihan walked into his new position facing a barrage of problems: The investigation into B of A’s acquisition of Merrill Lynch, friction with regulators, opponents in Congress who have questioned his leadership, and cultural issues within the company. He was able to created favorable buzz with small business.
Succession planning should be an ongoing strategic process. It’s vital for identifying talent and building a reserve bench for development. However, delays in succession planning result in a perceived lack of competence – image problems in the marketplace, among shareholders and internally with employees.
To empower shareholders as a policy matter, the Securities and Exchange Commission issued a nonbinding legal bulletin calling for transparency in management succession.
So it isn’t surprising that activist shareholders are going after the likes of B of A, American Express and Whole Foods regarding their succession plans. That includes the 500,000 member Laborers’ International Union of North America. The union is targeting 14 companies and asking them to disclose their succession plans in detail.
More than 1,ooo executives admit their problems with succession planning, according to a study by search firm Egon Zehnder International. It showed none of the responding executives believe they’re good at succession planning. Forty-seven percent admit being mediocre in the process of succession planning and 53 percent disclose their ineffectiveness.
“The global financial crisis has resulted in high CEO turnover. This fact combined with the recent SEC announcement that would allow shareholders to challenge the Board to disclose more information about plans for CEO succession, makes developing a succession plan even more critical,” says George L. Davis, Jr., an executive at Egon Zehnder International.
Responding were 1,092 senior executives in every business sector from a total of nine nations.
While the situation is untenable in the U.S., it’s worse overseas. Seventy-one percent of UK responders believe they’re just so-so in succession planning while 80 percent of French executives say they are unsuccessful.
But it isn’t bleak everywhere abroad. Fifty-seven percent in India believe they’re doing well. Seventy percent in Germany say they’re successful.
For small family businesses, succession planning is complicated by the federal estate tax. Also derisively called the death tax, it’s 45 percent after a $3.5 million threshold on heirs of family estates. The tax wasn’t imposed in 2010, but was scheduled to return in 2011.
Not to mention the time-consuming preparation for a business owner who is advanced in age, the estate tax is a nightmare for family businesses with considerable land, such as farms, or manufacturing equipment.
The tax jeopardizes the business. Because of cash flow, many heirs have to sell company assets to pay the tax.
Yes, some business owners incrementally transfer assets before their passing to avoid the harsh tax. But often some find they lose control of the business to their heirs while they’re still alive.
So don’t emulate B of A. You can do better in succession planning. And yes, it’s important in the public sector and nonprofits.
Some small business owners erroneously believe a will constitutes a succession plan. Not true. They’re not the same thing.
New businesses don’t need a succession plan. They should start thinking about a succession plan when the business starts to grow in value.
Professional guidance should be obtained.
Not to oversimplify, every case is different but here some basic elements to consider:
- If children are involved, first learn if it’s feasible for them to be involved in the family business.
- Get a sense from every family member regarding the business’ future.
- Give summer jobs to children that will expose them to all areas of the business. Not all kids are interested in eventually taking over. That’s disappointing to parents, but the sooner they know the better.
- If you have a partnership, you’ll need to draft a buy/sell document that includes an agreement on the business’ value so one partner can buy from the other. A shareholder agreement is customary for corporations.
- A vision for the business will be needed in case of death. To be decided – what should happen to the business and who will own the firm whether it’s a family member or partner. If the heir is not a relative but there are family members involved, an instrument should be devised in case the partner will buy out the shares of the surviving family members.
- After developing an agreement on the succession plan, then decide on insurance matters for liquidity purposes.
- Review the succession plan on a regular basis and update it as needed.
Finally, a word of caution: More than 90 percent of family businesses typically don’t succeed past the second generation.
Weak management is often the reason why inherited businesses do not succeed. And unless the children invest or buy the business from their parents, it usually doesn’t work. It’s often better if they don’t receive the business as a gift.
Not to be cruel, but the heirs simply don’t have the passion or ability to manage a business founded by their parents.
From the Coach’s Corner, here are related resources on management:
21 Quick Tips to Avoid the Dark Side of Management
Human Resources – Slow Motion Gets You There Faster
“Management must manage!”
-Harold S. Geneen
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Terry Corbell is a business-performance consultant and profit professional. Click here to see his management services (many are available online). For a complementary chat about your business situation or to schedule Terry Corbell as a speaker, why don’t you contact him today?
